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Suppose that a fall in conusmer spending causes a recession.
a. Illustrate the immediate change in the economy using both an aggregate-supply / aggregate-demand diagram and a Phillips-curve diagram. On both graphsm label the initial long-run equlibrium as point A and the resulting short-run equilibrium as point B. What happens to inflation and unemployment in the short run?
** In part a, draw both graphs for yourself and explain what you do. Indicate what happens to inflation and unemployment in the short run.
b. Now suppose that over time expected inflation changes in the sam direction that actual inflation changes. What happens to the position of the short-run Phillips curve? After the recession is over, does the economy face a better or worse set of inflation-unemployment combinations? Explain.
** In part b, indicate if you shift the short-run Phillips curve or if you move along it. Also indicate the direction of the shift or the move along the curve.
** = what needs to be completed.
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